401(k) FAQs for accountants and advisors

Do your clients have questions about offering a 401(k) plan? We've got most of the answers accountants and advisors need right here.

A 401(k) refresher (if you need it)

First things first — what is a 401(k)? Sometimes you'll hear people refer to a 401(k) as a type of defined contribution plan. That means participants make or receive specific contributions to their retirement account, but their retirement payout will not be guaranteed — it's ultimately based on the performance of investments that are held within the plan. The other type of qualified retirement plan, a defined benefit plan, gives participants a guaranteed benefit based on things like how long they work and how much they've earned. Pensions are an example of a defined benefit.

Defined contribution plans are sponsored by employers, who make decisions about their company's plan and are responsible for making sure it is administered for the benefit of all participants. Each employee's account can be funded by their employer — using a specific formula based on employee compensation or deferrals — or when an employee defers a portion of their pay. Whether the funds in an account are employer contributions or employee deferrals, funds go into a trust account for the benefit of participants, where they accrue earnings. At some point in the future, the employee will take distributions from their account.

IRS rules set limits for the amount of elective deferrals employees can make to their accounts each year. For 2026, that limit is $24,500. Employees ages 50-59 and 64+ can make an additional $8,000 in catch-up contributions. Employees ages 60–63 can make an even larger "super catch-up" contribution of up to $11,250 instead.¹

The tax advantages of a 401(k)

One of the attractive features of a 401(k) plan are the tax advantages for employees and employers²:

For employers:

• Thanks to the SECURE 2.0 Act (signed into law in December 2022), eligible businesses may be able to claim a tax credit³ of up to $16,500 over the first three years of their plan. 

• For employers with 50 or fewer employees, the startup credit covers 100% of "ordinary and necessary" plan setup costs — up to $5,000 per year for three years ($15,000 total). Employers with 51–100 employees can claim 50% of those costs, up to the same $5,000 annual cap.

• Plans that add an automatic enrollment provision (EACA or QACA) for the first time may also qualify for an auto-enrollment credit³ of up to $500 per year for three years ($1,500 total). This credit is in addition to the startup credit, bringing the potential maximum to $16,500 for eligible employers with 50 or fewer employees.

• Eligible costs associated with administering the plan can be deducted as business expenses², further reducing taxable income. (But note that a business can't take a credit and deduct the same costs.)

• Employer contributions to participant accounts are deductible from federal and state income taxes and exempt from payroll taxes — as long as they are under 25% of the total eligible compensation paid (or accrued) during the year and must be deposited in the plan's trust by the employer's tax filing deadline for that year, plus extensions.²

• SECURE 2.0 Act also added a new employer contribution tax credit for businesses that contribute to their employees' accounts. Employers with 50 or fewer employees can claim 100% of eligible employer contributions, up to $1,000 per employee earning $100,000 or less, for the plan's first two years; that percentage steps down to 75%, 50%, and 25% in years three through five before phasing out entirely in year six. Employers with 51–100 employees can claim a reduced percentage. This credit can be used at the same time as the startup and auto-enrollment credits above.

For employees:

• Traditional 401(k) deferrals: Employees make traditional deferrals on a pre-tax basis. That means the amount of taxable wages will be lower when they contribute to their 401(k) accounts. Participants are eventually taxed when they withdraw funds from their 401(k), but they're usually in a lower tax bracket by that time.²

• Roth 401(k) contributions: Employees make Roth deferrals on a post-tax basis. That means they pay taxes up front on the elective deferrals, but their funds will grow and be distributed potentially tax-free⁴ Thanks to SECURE 2.0, Roth 401(k) accounts are also no longer subject to required minimum distributions (RMDs) during the participant's lifetime — a significant advantage over traditional 401(k)s for long-term savers. Additionally, high earners (defined in 2026 as those who earned more than $150,000 in 2025) are required to make any catch-up contributions on a Roth basis.²

Up the ante: Matching and profit-sharing

Businesses that offer a 401(k) are not required to make any contributions to their employees, but more than half of our clients choose to. ⁶ Matching contributions can have a few huge benefits for everyone involved:

• As an expense, they generally reduce the taxable income of the business²

• They can make it easier to keep a 401(k) plan compliant (for an example, see the "Safe Harbor" section below)

• They allow owners and other well-compensated employees to receive more than the annual $24,500 deferral limit¹ (subject to catch-up)

While participants may only contribute $24,500 (subject to catch-up), employer matching and profit sharing contributions allow participants to potentially sock away up to $72,000 in 2026 when employee deferrals and employer contributions are combined (catch-up contributions do not count towards the total annual limit).¹

Are 401(k) plans required?

No states currently require employers to offer a specific kind of retirement plan, but several states have passed legislation that establishes a state-sponsored retirement plan⁵ (like CalSavers in California and OregonSaves in Oregon) and/or mandates that businesses provide a retirement plan. These state-sponsored plans are a helpful step for putting employees in better shape to retire but the contribution limits are low and they count towards the participant’s personal IRA deferral limit. A well-run 401(k) plan can mean low fees for businesses and employees with greater benefits, so it's worth shopping around.³

How do company owners and partners contribute to a 401(k)?

It's likely that your client is an owner of one or a number of businesses. They may be a shareholder in an S-Corporation, a member of an LLC, a general partner of a limited partnership, a sole proprietor, or maybe a combination of many of these (or others!). It's also possible that if an owner of a business offers a 401(k) plan to their employees, they will want to participate in the plan, too.

In general, an owner needs to have compensation (W2 or self employed income) from the company for actual work performed. Depending on the type of owner, certain additional criteria may need to be met:

• Owners receiving W2 compensation from the business will be able to defer part of their wages, up to $24,500 ($32,500 if age 50-59 or 64+, or $35,750 if ages 60-63) or 100% of wages, whichever is less¹. They'll also be eligible to receive employer profit sharing and matching. If the company is an S-Corporation and the owner is receiving both W2 and K1 income, only the W2 income can be used for plan purposes under the IRS Code.

• For sole proprietors and partners claiming income on a K1 or Schedule C from the business can only defer from actual earnings.  This deferral election must be made before the end of the plan year but the amount is calculated once taxes are prepared and actual earnings are known, and must be deposited before the tax filing deadline. A business owner can contribute up to the lesser of $24,500 ($32,500 if age 50-59 or 64+, or $35,750 if ages 60-63) or 100% of adjusted taxable earnings¹.

What do I need to do to stay compliant? And what's a Safe Harbor 401(k) plan?

One of the big things a good 401(k) provider (or its third party administrator) does is perform compliance monitoring and annual nondiscrimination testing — most notably the Actual Deferral Percentage ("ADP") and Actual Contribution Percentage ("ACP") tests. These tests are designed to make sure highly compensated employees (HCE) aren't benefiting under a company's plan disproportionate to non-HCEs. These tests compare deferral and contribution rates between HCEs and non-HCEs.

You can learn a lot more about compliance testing here, but there are a few scenarios where companies are at risk of failing testing (even if they're doing everything they can to run an equitable plan):

• Small company size: It's easy for the ratio to get out of whack when the sample size is very small — such as in companies with fewer than 10 employees.

• HCEs with low wages: When owners and managers have low wages and they make (relatively) large contributions, it can lead to testing failures.

• Large wage discrepancy: Businesses with lots of hourly employees, especially, can run into compliance issues.

• High proportion of owners to other employees

• Plans that start late in the year: When a plan is launched near the end of the year, HCEs may try to make a full year's worth of contributions, while non-HCEs won't have the financial flexibility to do so.

Safe Harbor to the rescue

One suggestion you can make for clients who wish to keep their 401(k) plan compliant — and simple — is a Safe Harbor plan. A Safe Harbor 401(k) plan is deemed to pass most discrimination testing. To qualify as a Safe Harbor plan, in addition to possible notices, a sponsor must make contributions to participants' accounts, and there are limits on the vesting schedules that can apply to those contributions. There are two types of Safe Harbor provisions — traditional and QACA (Qualified Automatic Contribution Arrangement), which combines the safe harbor provisions with an automatic enrollment provision.

There are a number of ways to meet this requirement:

• Traditional basic match. The employer matches 100% of the 401(k) deferrals each participant makes, up to 3% of that employee's pre-tax compensation. The employer also agrees to match 50% of the next 2% of compensation that is deferred.

• QACA basic match. The employer matches 100% of the 401(k) deferrals each participant makes, up to 1% of that employee's pre-tax compensation. The employer also agrees to match 50% of the next 5% of compensation that is deferred.

• Enhanced match. The employer matches at a rate at least as favorable as the basic match for the safe harbor type (e.g. 100% of the 401(k) deferrals up to 4%) limited to matching on 6% of deferrals made.

• Non-elective contribution. The employer contributes a certain amount to all employees eligible to participate in the plan, whether or not they make 401(k) deferrals. The Safe Harbor non-elective minimum is 3% of compensation.

It's important to remember that Traditional Safe Harbor contributions must immediately vest for all employees while QACA Safe Harbor contributions can be subject to a two year vesting schedule.

More key 401(k) considerations

Profit sharing

Another great option for clients who can afford it is a profit-sharing feature. With profit sharing, the employer contributes an amount they determine each year (this amount can be zero). The amount is then allocated to all eligible participants based on a formula specified in the plan document. 

Profit-sharing is a generous benefit. A tax professional's counsel can be critical in helping them make a prudent decision about what level of profit sharing to provide each year. Here's some more detailed information if you want to dive in.

401(k) matching

Another generous benefit that many businesses like to offer is a 401(k) match. A match is a contribution by the company, following a specific formula — made to participants based on their own deferrals — as an incentive for them to contribute. Matching is not mandatory but can provide a significant boost to your employees' savings.

Switching from another type of retirement plan

If your client already offers another kind of retirement plan, like a SIMPLE IRA, SEP IRA, or 403(b) plan, they can always switch to a 401(k). It will be crucial for any client considering this change to know the difference between their current requirements and those of a 401(k) plan. Switching to a 401(k) could mean an increase in costs and resources required to stay compliant.²

Third-party audit requirement

In addition to the IRS nondiscrimination tests, the Employee Retirement Income Security Act of 1974 (ERISA) requires an annual audit of large retirement plans (with more than 100 participants) by an independent Certified Public Accountant. For this purpose, a participant is defined as an individual (current or former employee or beneficiary) with an account balance at the beginning of the year.

The audit requirement is an important piece of compliance, and you should let clients know about it (and the added expenses it may require) when they set up a plan that may be subject to the requirement.

FAQs

What is the difference between a defined contribution plan and a defined benefit plan?

A defined contribution plan (like a 401(k)) has participants make specific contributions with payouts based on investment performance. A defined benefit plan (like a pension) guarantees a specific benefit based on tenure and earnings.

Can business owners participate in their company's 401(k)?

Yes, but rules vary by ownership type. W-2 employees can defer wages up to IRS limits. If the company is an S-Corporation and the owner is receiving both W2 and K1 income, only the W2 income can be used for plan purposes under the IRS Code. Owners with self employment income (either K1 or Schedule C) must have profitable businesses and base contributions on self-employment earnings.

What is a Safe Harbor 401(k) plan?

A Safe Harbor plan exempts sponsors from most annual nondiscrimination testing by requiring employer contributions through basic matching, enhanced matching, or non-elective contributions as well as other notice and vesting requirements.

What are the tax advantages of a 401(k) for employers?

Certain employers may claim tax credits of up to $16,500 over three years (startup and auto-enrollment tax credit), deduct plan administration costs as business expenses, and deduct employer contributions from federal/state income taxes.³

Disclosures

¹ May be adjusted annually to account for IRS cost-of-living adjustments. Learn more. 

² This content is for informational purposes only and is not intended to be taken as tax advice. Please contact a tax professional for further information.

³You should consult a tax professional to determine what types of tax credits or deductions your company is eligible to claim.

⁴ Roth contributions are always distributed tax-free. The earnings on Roth contributions will be tax-free if: (a) you're either over age 59½, disabled, or have died AND (b) it has been 5 years since your first Roth contribution under the current plan. Please consult a qualified financial advisor or tax professional to determine what is applicable to your financial situation.

⁵ This information is general in nature and is for informational purposes only. It should not be used as a substitute for specific tax, legal and/or financial advice that considers all relevant facts and circumstances. Deadlines, fees, and other program details are subject to change by the state without notice and should be checked prior to making any decisions.

⁶ Information accurate as of June 2026